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The Tail that Wags the Economy: Beliefs and Persistent Stagnation

Author

Listed:
  • Julian Kozlowski
  • Laura Veldkamp
  • Venky Venkateswaran

Abstract

The Great Recession was a deep downturn with long-lasting effects on credit markets, labor markets and output. While narratives about what caused the recession abound, the persistence of GDP below its pre-crisis trend is puzzling. We propose a simple persistence mechanism that can be easily quantified and combined with existing models, even complex ones. Our solution rests on the premise that no one knows the true distribution of shocks to the economy. If agents use observed macro data to estimate this distribution non-parametrically, then transitory events, especially extreme events, generate persistent changes in beliefs and thus in macro outcomes. We apply our tool to an existing model, designed to explain the onset of the great recession, and find that adding belief updating endogenously generates the persistence of the downward shift in US output, colloquially known as “secular stagnation.”

Suggested Citation

  • Julian Kozlowski & Laura Veldkamp & Venky Venkateswaran, 2015. "The Tail that Wags the Economy: Beliefs and Persistent Stagnation," NBER Working Papers 21719, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:21719
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    File URL: http://www.nber.org/papers/w21719.pdf
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    References listed on IDEAS

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    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Central Banks and Systematic Risks
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2016-03-21 17:41:06
    2. How risky are the big U.S. banks?
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2016-10-03 17:58:45
    3. Financial Crisis: The Endgame
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2018-09-03 12:25:40

    Citations

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    Cited by:

    1. Robert Ulbricht & Ludwig Straub, 2015. "Endogenous Uncertainty and Credit Crunches," 2015 Meeting Papers 199, Society for Economic Dynamics.
    2. repec:eee:juecon:v:106:y:2018:i:c:p:81-100 is not listed on IDEAS
    3. Martin Guzman & Joseph E. Stiglitz, 2016. "Pseudo-wealth and Consumption Fluctuations," NBER Working Papers 22838, National Bureau of Economic Research, Inc.
    4. Jesus Fernandez-Villaverde & Lee Ohanian, 2018. "The Lack of European Productivity Growth: Causes and Lessons for the U.S," PIER Working Paper Archive 18-024, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 07 Sep 2018.
    5. repec:aea:jecper:v:31:y:2017:i:3:p:47-66 is not listed on IDEAS

    More about this item

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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